With tough economic times ahead across our region and beyond, it’s crucial that businesses protect themselves against insolvency. Leicestershire Builder’s regular contributor Michael Gerard of Michael Gerard Solicitors (www.mg-law.co.uk) offers some timely advice.
As history has taught us, construction is always one of the first sectors to be hit by economic downturns and although COVID-19 is causing a new breed of recession, this fact remains unchanged, with our sector steeling itself for significant ramifications nationally and globally. Add to that the unique set of concerns in Leicestershire, with the city’s localised lockdown impacting on a range of industries, including the building trade and all its affiliated industries.
Defining insolvency in contracts
The main JCT forms have a section dedicated to termination with one ground for ending a contract being insolvency. The JCT also defines what insolvency means, including the legal entities of a company, a partnership and an individual. Essentially, it occurs when a party enters into a formal insolvency procedure, such as administration within the meaning of Schedule B1 to the Insolvency Act 1986, or the passing of a resolution for voluntary winding-up without a declaration of solvency under section 89 of Insolvency Act 1986.
Where one party to the contract has become insolvent (as per the definition), the other party can give notice to the insolvent party to terminate the contractor’s employment under the contract. Although this appears straightforward, the notice must comply with the conditions of the contract – including how the notice is served. Where an employer terminates the contractor’s employment:
- No further payments are due to the contractor until the work is completed.
- The employer may employ others to have the works carried out and completed at which point, the employer sets out what it has cost to complete, including any damages caused by the termination.
- Alternatively, the employer may choose not to have the works carried out and completed. Where this occurs, there is a process to work out the final account.
What about common law?
At common law, insolvency in isolation is not a breach of contract, but the effect can result in the party becoming insolvent to wrongly repudiate the contract, thus allowing the other party to accept the repudiatory breach and bring the contract to an end. For example, where a contractor has failed for several days to supply physical resources for the project (maybe because it can’t afford to pay for the resources), it could be said that the contractor has abandoned the works.
Sections 122(1)(f) and 123(1) of the Insolvency Act 1986 define insolvency as where a company is unable to pay its debts when they are due, which is in contrast to the JCT suite of contracts which defines insolvency as when a party has entered into some formal insolvency procedure.
How to maintain a healthy cash flow
It is now more important than ever for suppliers of goods and services to maintain a safe cushion of cash in the bank. Sometimes easier said than done. The answer lies in insisting on favourable payment terms and ensuring robust mitigation measures are in place:
- Ensure the valuations are as frequent as possible. Under standard forms of contract, like the JCT, there is the option of having the valuation periods geared to milestones or periods of time. Usually, the valuations will be periods of time (monthly), and this continues post practical completion. However, there is nothing to stop a contractor negotiating fortnightly valuations, with perhaps a small discount as an incentive for the employer.
- Ensure that the period between the end date of the valuation and the final date for payment is as close together as possible. Under standard forms of contract, the period is around 17 days, but again, this can be shorter if the parties agree – perhaps a small discount offered could persuade the client to agree to a quicker final date for payment?
- When a payment is late, don’t hesitate to threaten suspending performance of the works. However, prior to this, a notice of the intention to suspend must first be issued – which may in itself serve as a ‘reminder’ to the debtor to pay up. Do not hesitate to suspend performance if payment is late, as you could be throwing good money after bad should the employer cease trading.
- Incorporate a paid-when-paid clause for insolvency events for downstream payments. This will protect the business in case of an upstream insolvency.
- Consider including a ‘Romalpa’ clause (retention of title). However, even with a Romalpa clause, it may not be enough to recover goods supplied if those goods are annexed to the structure.
- Collateral warranties are particularly useful for third party funders and future purchasers of buildings where there are defects in the structure, but the developer may have ceased trading. Collateral warranties can also be good news for contractors and consultants if the warranty includes step-in rights and payment of outstanding sums.
- Third Party (Rights Against Insurers) Act 2020 legislation enables claimants to bring proceedings against insurers of defaulting insolvent companies. This is particularly useful where latent defects arise, but the contractor has ceased trading.
- Ensure that the contract includes a termination clause for party insolvency that also sets out what happens post termination.
When it comes to protecting against insolvency over the next couple of years, good fiscal and commercial management systems are key to survival in the highly challenging economic environment ahead. Taking the time to review your standard terms of contract now could make all the difference.
Michael Gerard is a solicitor, practising adjudicator and accredited expert in quantum and planning. He is a Fellow of the Chartered Institute of Building, a registered adjudicator and vice chair of the East Midlands branch of the Chartered Institute of Arbitrators. He is also a registered adjudicator on the panels of the Royal Institute of British Architects, the Chartered Institute of Arbitrators and Hunt ADR. He is the founding partner of Michael Gerard Solicitors (www.mg-law.co.uk).